US Appeals Court Strikes Down Law Taxing Damage Awards

by Mike Godfrey, Tax-News.com, Washington

25 August 2006

The US Court of Appeals for the District of Columbia Circuit has ruled that a law taxing compensation awards for emotional injury is unconstitutional, a ruling which may open the door for future challenges to US tax laws.

The ruling concerned the $20,665 in tax paid by Marrita Murphy on a $45,000 emotional distress and $25,000 injury to reputation payout, awarded after she blew the whistle on the New York Air National Guard with regard to environmental hazards at an air base.

While legal compensation for physical injuries is tax-free under a 1996 statute, monies awarded for mental anguish and injury to reputation are not.

However, the three-judge panel unanimously decided that the award wasn't taxable income under the Constitution's 16th Amendment because it didn't compensate for lost wages or earnings.

Although the ruling affects only plaintiffs in the District of Colombia, jurists and tax law experts predict that it will encourage more challenges to the tax code on constitutional grounds. Some also worry that it could result in more 'frivolous' claims that income tax in general is unconstitutional.

The government has yet to announce whether it will challenge the ruling, but an appeal to the Supreme Court is thought likely.

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